Why “Earn More” vs. “Save More” is the Wrong Debate

It’s time to wave the truce flag over one of personal finance’s greatest battles.

One of the most spirited debates in personal finance circles is the classic “earn more” vs. “save more” standoff.

The “earn more” crowd argues that raising your income is the best way to reach financial independence. There’s no upper limit to this potential, especially if you’re an entrepreneur.

The “save more” crowd argues that, left unchecked, income and spending naturally scale together. Focusing on frugality, therefore, is a better method for creating financial independence.

Here’s what neither side admits:
Both hold unstated assumptions. The “earn more” crowd believes that they’ll spend a fixed amount, regardless of their income. The “save more” crowd believes that they’ll spend a percentage of their income.

The debate boils down to this difference in worldview.

The classic argument “if you earn more, you’ll spend more” is based on behavior and mindset. It argues that people spend a proportion of their income — 90 percent, 80 percent, 50 percent, whatever — regardless of how much they earn.

The counterargument “the more you earn, the easier it is to save” focuses on math and logic. It argues that you need a baseline foundation to cover your cost-of-living plus reasonable comforts. The surplus goes directly to savings; therefore, higher surpluses equal more savings.

Both sides, though, focus on growing the gap between income and spending. And that’s where this conversation needs to turn.

The gap should be our one and only focus. Here’s how I define this gap:

You earn $X. You spend $Y. The gap is the difference, $X-$Y.

Your job is simple: make this gap as large as possible. You can push $X higher. You can drive $Y lower. You can attack both simultaneously. The size of the gap matters more than the method you choose.

Once you’ve grown the gap, invest this into anything that creates cash flow. “Cash flow” are the critical words. Your home is not an investment. It’s cash-flow-negative. Rental properties, index funds, and owning a business, however, enhance your account balances rather than deplete it. These are great uses for the gap.

Let’s look at the power of the gap.

You earn $100,000 annually after taxes. You spend $60,000 and create a gap of $40,000 per year, which you invest in index funds that grow at 7 percent compounding annually. After 19 years, you’ve grown $1.5 million.

If you quit working and withdraw 4 percent of this, you’ll have $60,000 per year before taxes for the rest of your life. That’s financial independence in less than two decades (or faster, if you fling raises into investments).

Can we pause for a moment? We just outlined $0 to retirement in 19 years. Nineteen years. And this happened while living on a comfortable $60,000 of annual spending, which isn’t a fringe extreme.

In fact, let’s take a step back. Let’s imagine a different situation. You want to retire to a balmy beach in Thailand on $40,000 per year. How much money will you need? Let’s figure this out in our heads, within a few seconds, using easy back-of-the-napkin rules-of-thumb.

If you prefer index funds:

The 4 Percent Rule: You can sustainably live on 4 percent of your investments every year. In other words, $1 million in your portfolio means you can live on $40,000, adjusted for inflation, every year.

The 25x Rule: Calculate the amount you want to live on. Multiply by 25. This is the size your portfolio needs to be. Notice the relationship to the 4 percent rule — $40,000 x 25 equals $1 million.

If you prefer rental properties:

The 1 Percent Rule: Your rental properties should collect one percent of their value in monthly rent. In other words, $1 million worth of rentals should collect $10,000 per month in top-line revenue. (“There’s nothing in my area!” — Go where the money is.)

The 50 Percent Rule: Half of the rent will get gobbled up by operating costs, such as repairs, maintenance, management, etc. The implication: if you hold free-and-clear properties that meet the 1 percent rule, you can expect to pocket 6 percent of the home’s value every year, after expenses.

How soon can you retire to a tropical Thai island, based on these general parameters? If you invest in index funds, you’ll need $1 million. If you invest in rental properties, you’ll need $660,000 in properties free-and-clear.

Your target, therefore, is to build $660,000 – $1 million worth of investments. Reach this singular goal, and you’ll receive $40,000 in passive income for the rest of your life. If that income feels too low, double everything. You’ll need $1.3 – $2 million to create $80,000 in passive income per year.

Some of you might be thinking: “Really? That’s it?,” while others might think these numbers sound daunting. To those in the latter group: everything worthwhile feels daunting at the start, and even the most complex situations feel easy in hindsight.

You’ve mastered driving a car, memorizing all 50 states, filing taxes, and all types of other cognitively complex behaviors. You can manage this, too. You’ve already taken the first step. You’ve built the map. You know the goal. Now the focus is growing the gap.

Financial independence boils down to one simple focus: the gap. Grow it. Invest it. Repeat. There’s not much more to say. We can draw diagrams and build models under a hailstorm of variables, juicing ourselves with pure nerd-fun along the way. But this spreadsheet tinkering isn’t necessary.

The only road to financial independence comes from focusing on the gap. Do this one thing, and everything else falls into place.

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Comments

Great points. I think its vital that you take the steps to do both save money and try and gain more income all while trying to build that cash flow. At the end of the day, cash flow is what is most important to me.

I literally am moving from a high priced market to a low priced market just so I can take advantage of the real estate deals and help propel my financial freedom. Its a big move but in the end all i see is cash flow!!! 🙂

Unless you’ve lost over half of your investments in the Great Recession of 2008. We are still retired but you need to realize that things don’t always work out as planned.
We had to downsize which was fine but investments of any kind aren’t guaranteed to grow.

@Tina — I hope that you withdrew most of your money from your bond allocation, rather than your stock funds, in 2008 and 2009. Bonds performed well during the recession, and as a retiree, I assume you have a healthy dose of bonds in your portfolio. Sell the winners when they’re high — and bonds were high in those years!

If you stuck to the 4% withdrawal rate, you’d only turn a small amount of “paper loss” into “real loss.” The majority of your stock portfolio should’ve stayed invested throughout the recovery.

The gap is critical! If you need less to live on, you need less invested. It does not matter how you get there, it only matters that you get there. I’m with Paula and working really hard on a skill that will double my income. The “excess” will go into driving down my debt and driving up my assets. I will do both at once and not focus on paying down debt, because I want time in the market compounding for my benefit. The current napkin says that it’ll take two years at the doubled-income to pay off all student debt and three more years to be financially free. I love this napkin.

Love the grow the gap. It is one of those “simple” phrases people can remember and take action on. Paula – have you ever written about pensions and how they play in to this? The 4% rule and 25X rule look different when you get a pension (or two pensions in our case). Maybe it is mind the gap there too? Grow the gap between the projected pension and your spending? Maybe there is a different way to think about it too!

Great way to explain FI in a nutshell. After your talk about real estate at Camp Mustache this year, I keep thinking about how one can use leverage to accelerate FI through buying rental properties. Pretty interesting stuff!

Our goal for retirement in 26-30 years is $80k-$100k yearly in today’s dollars . Am I crazy for thinking that with a $2mil 401k by the time we retire and $600k real estate bought today held until retirement that we’ve basically achieved that goal- without factoring in social security?

It really depends on your assumptions about inflation, rental returns and your withdrawal rate. In your comment, you say “$600k in real estate bought today and held until retirement.” Does that mean at retirement that you sell the real estate? Keep it an spend the cashflows?

Since I have no idea what kind of real estate returns you are expecting, I ran a quick calculation to figure in your 401k ONLY. I assumed a 3.32% annual average inflation rate (which is the annual rate from 1913-2013 in the US*), and assume a portfolio value of $2 million 30 years from now at a 4% withdrawal rate.

Given that, your annual income from the 401k would be $80k in 2046 dollars which would be the equivalent of $30,030 in 2016 dollars.

Therefore, your real estate income would need to make up the difference. It would have to account for at least $50k per year in today’s dollars. Next question: is a $600k RE portfolio capable of producing $50k a year in profit? Lucky for you, I made a spreadsheet that will tell us the answer!

Well, let’s assume those properties are paid for. Let’s also assume that, as an aggregate, the RE portfolio just meets the 1% rule (in other words, monthly rent is 1% of the total value of the properties or $6,000/month). Let’s assume $6,000/yr in property taxes, 8% (of rent) for property management, 5% vacancy, 10% (of rent) in repairs, and 5% (of rent) in CapEx.

That suggests you could expect something in the neighborhood of $45,000 annual net cashflow (not counting taxes).

So, in today’s dollars, you’d be close to your goal of $80k/year. Add in future growth assumptions about rental increases, inflation, etc and you’d either be higher or lower, but you would be in the ballpark.

Looking forward to 30 years from now, you might have made profit on those rentals while paying them off. Where did that money go? Did you reinvest it or spend it?

Anyway, since we’re talking about the future and lots of assumptions, it’s a complex calculation, but hopefully that gives you a decent idea.

*Seriously: I don’t want to hear from any other commenter about how the “real inflation rate is X%! The government is lying to you!” (where X is some really big number). If I wanted to hear that stuff, I’d go to some alarmist site like ZeroHedge and become a goldbug.

I think focusing on the gap is the best plan. I’m not sure why there is a “save more” camp and an “earn more” camp. Why can’t we do both. I’m more of a “save more” person, not because I think my spending will increase but because I think it’s easier. Increasing your income is just harder IMHO. There is a personal finance guru who I respect and enjoy his stuff but he seems to be bashing the “save more” camp at times. He’s trying to sell a course to teach others to build a profitable business by creating their course…but that’s just not that easy. Not saying it can’t be done…it’s just much more difficult compared to living within your means. I’m going to try to “side hustle” and maybe try and build an online business, but frugality and saving just comes naturally.

yeah, creating that gap (with raises and saving more) is the best thing to do – and can be loads of fun!

i agree with andrew. earning more is much harder. i could earn more by taking higher-level positions in my field, but that means more days – and those days would be longer! and i’d probably be more stressed!

and to “take the edge off” i’d probably spend more on fast food and other trifling indulgences….so it’d be a wash in the end!

Great article. I just finished reading all of MMM’s posts over a six month period. I think he says the same things but I really like your style. It makes me look at what I have and I feel confident about the future since I am conscience of the gap.

GREAT Post, as are most. I have unsubcribed to many email lists. I kept yours and this post is why.
I love your clear concise writing, it is always very thorough without bogging us down in the minutia.

i enjoyed your posts ! my comment is about the 50% rule…when mentioning the homes value , i use the purchase price, the amount invested .
any yearly increase in the homes value is a separate non cash return.

The point about throwing any extra income into your investments is the key to widen the gap. Almost everyone, even fast food workers, will increase their earnings over time. Putting the vast majority of that “extra” money into appreciating assets is essential.

Great article, I definitely agree. In my early 20s, even with a good engineering job straight out of college the gap never grew for me. I spent all my money on my brand new car and going to the bars. Too bad I can’t go back in time to tell my younger self to get my act together. As a matter of fact, we would all be better off financially if Elon Musk focus all his energy on a time machine rather than his silly idea for an electric autonomous driving cars.

Just joking…I like to add that one can do both, rental property and index funds. I believe that passive income diversification is good way to hedge potential volatility in the equity or in the real estate markets. Asset allocation is just as important as passive income allocation.

I’ve been saving to a Roth IRA account with index funds since I turned 30, but I’m limited to investing only $5500 per year… at that rate, it’ll take 113 years for me to meet my modest retirement goal! How can I possibly retire in 19 years, even if I earn more than I now do?

That depends, of course on what other avenues of investing are available to you. Are you assuming that your only possible investing option is your Roth IRA, and every other dollar over that amount is subject to some legal requirement that it must be spent?

Also, what is your math regarding the 113 year calculation? Are you putting your money in cash or something?

What a great way to sum it all up! I thought you might be oversimplifying or overpromising when I read your headline, but you totally delivered. I’ve been trying to convince people of this for a while. It’s all about that gap and setting targets – thanks for making it so clear!

Great article. What I love about this is it gives more than one way to reach financial independence and actual numbers. The cool thing is if you live off of less than you can adjust accordingly. I think a combination of both earn more and save more makes the journey to independence much easier.

Hey Paula, really enjoyed this post as well. I totally get your point. I do have a question about the following:
The 1 Percent Rule: Your rental properties should collect one percent of their value in monthly rent. In other words, $1 million worth of rentals should collect $10,000 per month in top-line revenue. (“There’s nothing in my area!” — Go where the money is.)

We live in a really expensive area as far as housing (Miami, Fl) and even though over the last 12 years our rental properties have appreciated and rents increased, we still do not fall within that 1 percent rule. At a present value slightly over one million, our monthly rents only generate $8,400.00. If we calculate it so that the purchase price were taken into the equation ($780k), yes, we generate more than the 1% . We have just retired and we think this will suffice for our income along with SS and the plan is to not touch our retirement savings unless we have to. So my question is, are you sure present value is correct and not purchase price???
Anyway, this post really made me think and wanted to thank you for your insight.

Great question. I meant that at the time you purchase a rental property, it should rent for one percent of its purchase price, plus any initial repairs needed to get it rent-ready for the first tenant. In other words, it should rent for one percent of the total acquisition price.

If you paid $780k for your properties and they’re grossing $7,800+ per month in revenue, in other words, you meet the One Percent Rule. 🙂

Awesome article. Great point that growing the gap is key. I have absolutely loved every second of my 16 years in the military, but I have no way to increase my income beyond what my ranks says I can earn. I’ll take that generous military retirement in four years and try for more money doing real estate full time(which is why I love your blog!). I’m off to a decent start buying rental properties and paying them off while I’ve been in the military. Keep up the great writing!

Seems like you’ve found a way to kick ass despite your hands being tied. I hopped over to your site and your numbers are amazing! Good on you. Your story reminds me of Paula’s recent podcast (#33) featuring Doug Nordman – did you hear it? If not, it’s worth a listen! 🙂

Terrific article – simple, to the point. I just had a small question: Is the 4% on the index funds taking taxes into account? I saw inflation, however, I didn’t notice capital gains tax. I imagine one cannot invest entirely in tax-free accounts. How does that affect the calculation?

Yeah, I’ve never understood this debate. Why choose between earning and saving more? Why not do both, to the max? I think maybe the pro-earning crowd in part is just looking for an excuse to spend with abandon, guilt-free.

One little tidbit I do like to mention in this context: $100 saved means a $100 net worth increase while $100 earned translates to $80-$85 net worth increase, after taxes. Even Uncle Sam hasn’t figured a way to tax money we choose not to spend. 🙂

Couldn’t agree more with the point of the article. Can’t both sides of the argument be right? Both parties have the interest of increasing their savings one way or the other. Saving every single dollar will always help, along with earning a few extra dollars here and there. All that matters is you are setting yourself in a better financial position and getting ready for the future.

Yes – Mind the gap!! This means you can both earn more and spend less and the gap will keep growing. Why limit yourself to one or the other?

I am bothered by the fact that some people say to earn more by negotiating a higher salary or starting wage. That is awesome advice for some but in many cases that isn’t an option. As Rich On Money pointed out, his military compensation is somewhat set. My job as a flight attendant makes me an hourly employee supported by a union – if they give me a raise they have to give all my fellow stews a raise and that’s not likely to happen. However, I am fortunate enough to be able to choose to work more hours or I can work less and pick up a side hustle. Spending less on top of that helps to stretch the gap to the max.

Thanks, as always, for your insight. Looking forward to the next podcast! 🙂

Great post! I used to live within my means, it didn’t matter how little or more I earned, I still ended up living payday to payday. Now I’ve committed to saving, anything extra I earn is being safely saved away until I have my first home. After that I’ll look at investments. I’ll have to check out your podcast too! Thanks for sharing.

Gotta love the gap! I made sure to grow my gap this past year by cutting out cable, lowering car insurance, reducing my rent by 10%, and getting a raise at work. The savings are huge and the only reason is because of that awesome gap.

People should focus on both, increasing income while reducing spending. This is the best way to expedite FI. It seems that a lot of frugal FI bloggers only focus on saving, and retiring a minimalist. I fear they will run out of money in retirement because life just gets expensive and unknown costs will happen in the future. For example, mobile phone and data bills were not considered in retirement planning 25 years ago, they didn’t exist. New expenses, inflation, and unforeseen events will always happen. Being prepared by earning more and saving more is the right thing to do.

I would say financial independence can be achieved if you decide a certain living lifestyle. So let’s say if you were living on $6,000 a month prior to your income increase and you maintain it after your income is UP (let’s say $8,000 a month) then you can use the rest of the money in other investments, donations, charity etc.

This is surely a debate that will never go away. I always say earn more and scale the heck out of things! You’re sure to win when your business grows exponentially. Then hire a great financial advisor and learn as you go. I have seen so many people make a tons of money online only to lose it shortly after.

Hi Paula, Just read your About section and I have to say that it’s a really nice journey that you’ve had, so I’m not going to question your advice on these matters. As long as the strategy makes enough money while I’m sleeping, then that’s fine by me.

So much advice focuses on “You need $2,000,000 to retire on.” Well, that doesn’t account for spending, nor does it account for anyone having a job-related retirement plan. My wife and I are retired, and we don’t have $2,000,000 in investments. Between my teacher’s retirement and our investments, we’re bringing in $43,000 a year.

You’ve really spelled it out well. I’ve never thought about rental property, although we are renting our first home to my son and his wife. Since it’s paid for, it’s bringing in some money that I don’t even account for. We’re letting that build in an account of its own.

Earning more money has more magnitude, leverage, and impact than saving.

Here is a list of other reasons to focus more on earning:

1. Earning more is more admirable than saving more.
2. You feel better about yourself when you earn more.
3. Your quality of life increases when you earn more.
4. Lastly, earning more can buy you more time. Saving costs you time.

I really wish practical financial stability was taught in school. More than just the bare bones mathematics of it but the actual practicality of it being done, would’ve been a huge help years ago. Because things are all kinds of crazy right now. Not to say that anyone else never had it as hard or anything like that. 100,000 annually though and ONLY spending 60,000! Holy crap! But hey what do I know, just some 21 year old that lives in a place where prices are way to high for everything and is at work for more hours than he’s at the apartment he’s working to pay rent for. Now if you see this comment, I’d love to know what you’re thinking right at this moment. Then read on, I’m not looking for handouts, because everything I’ve learned in life that has been through my own failure or older wiser people who have either failed or had success before me. So with that being said, this article was a very intriguing read and I’d love for the person responsible for creating such a peice to do another on how young people can get ahead of the curve in their opinion and do better than live paycheck to paycheck! And for all you older/wiser folks out there, laughing on the outside, I know what you’re thinking. no I don’t spend all my money on random things I do not need! No I don’t go out with friends every night or even every weekend or even every month. No I don’t have a fancy car I can’t afford. No my apartment isn’t anything above par either! As a matter a fact, I don’t even have a car right now! My second car just met the end of the line at 250,000 miles after I use to drive to work 60 miles a day every day which took 2 hours to get there and 2 hours back every day. No I don’t drive like a grandma, that’s literally just how bad traffic is out here. I got lucky enough where my grandmother is out of town and I’m luckily getting to borrow her car from her for maybe a week while I find out if I’m gunna risk it for the third time with a used car or bite the bullet and get a car loan and risk it trashing my credit. Not that I can’t figure out how to pay it but just from one of the articles on this site it made me think twice about it. I’ve got enough money each month to pay rent, get groceries sometimes, and pay utilities. After that I have a little wiggle room and that’s about it. I almost regularly work 40+ hours a week, commute now only takes an hour instead of two, and no this isn’t minimum wage, I’m make $13 an hour and have been working extremely hard to get just that, I received a raise before I had even worked a month at my job and am on track to continue growing. On top of that I also do freelance graphic design work on the side to make sure I can make ends meet. Yes I did start to go for school for that but school even with financial aid couldn’t pay rent out here so I had to drop my classes in order to pay rent without being evicted. Oh, but there’s online classes you say, yes there is, but I also work anywhere from 8 to 10 hours out the day, commute a regular total of 2 hours each day, bringing your total to 12, I do graphic design work to make ends meet that can take anywhere from 4-8 more hours out my day, leaving 4 to 6 hours of sleep maybe. Move closer to work you say. Rent is to high any place even 10miles closer to my work. But the gas money it saves you should even out you say. Not really, rent is REALLY that much higher, even if I could move closer, I couldn’t, I don’t make enough money to qualify to move to any of those closer places. Get a different job you say. Very funny! It took 6months to find one, no one is hiring right now nor have I actually ever seen a now hiring sign in all my time living in this state. I’m sorry that was so long. I forsaw a lot of speculation happening on a broad majority of any replies that only read to a certain spot in this reply. So I wanted to make a few things clear.

I apologize for the extremely long post, you don’t even have to accept the post if you don’t want to, I landed on this article after I landed on one of your other ones and have been stuck in this never ending hole of paycheck to paycheck as long as I can remember even my parents. I feel like they could never catch a break and neither could I. Never really put any of that frustration into words and after an extremely long work week, something about the this article and the other about car loans ruining your credit just made me snap into a thumb stomping terror of writing frustration. I just read the beginner post you have on your home page of your site here and even though many are things I’ve heard of before and have even tried to implement in my life before, saving the 1% thing may be something I’ll start trying, because that anti-budget sounds like the exact mental kick I need. I’ve been way to focused on what exactly I’m spending and what I can cut back to the point where even though there wasn’t much at all to cut back on, it pretty much bare bones right now. But thanks for the blog posts I’m sure I’ll read a few more(:

Thank you, Paula … I have these “wild and crazy” dreams and your post helps me to understand that they are worth pursuing… rental income. Blessings and Peace always and abundant prosperity as you share abundance with me.

So the answer is both and yet not both (since the gap is technically independent). How Buddhistic! I actually like that there are 2 silos of thought on this because people are all over the map financially and need reminders on all fronts.

A balance has to be maintained between spending and saving. It’s true that there’s no upper limit to your earning potential, but you ought to develop a budgeting strategy. Increasing your chances to earn more often gets influenced by a number of external factors, so you must learn how to manage your finances and enhance your savings opportunities.

While there are always several factors that help determine the state of one’s financial situation, we can benefit from taking a look at our actions & thought processes in regard to our finances.

Also, expanding the gap between dollars spent versus dollars earned should make for a more efficient technique for achieving financial goals, rather than attempting to ‘choose’ between which method works best to reach the same results.